A real estate syndication is an alliance of investors that join together to manage the acquisition of property, which would be difficult, or impossible, to effect individually. Syndication makes it easy for individuals to pool their resources and share risks.
It is the perfect way for investors to pool their financial and intellectual resources to invest in properties and projects much bigger than they could afford or manage on their own.
In the past, only the wealthiest individuals could participate in these types of syndications; after all, these would usually invest several million in commercial real estate projects around the country.
However, the emergence of real estate crowdfunding since the JOBS Act passed in 2012 has facilitated an individual’s access to real estate syndication.
Now that it’s more accessible than ever, let’s look into the basics of real estate syndication and how it works in more detail
Real estate syndication is a transaction between a Sponsor and a group of Investors.
As the manager and operator of the deal, the Sponsor is in charge of scouting out the property and raising funds. This is known as sweat equity and it is their main investment. They also acquire and manage the asset’s day-to-day operations.
Meanwhile, the Investors, provide most of the financial equity.
The Sponsor is usually responsible for investing anywhere from 5-20% of the total required equity capital. Then, investors put in between 80-95% of the total.
Most importantly, the more the Sponsor invests in the deal, the better for you as the Investor, so you’ll want your Sponsor to have as much skin in the game as possible.
The Legal Structure of a Real Estate Syndication
Syndications are usually structured as a Limited Liability Company or a Limited Partnership. The Sponsor participates as the General Partner or Manager. And the investors participate as limited partners or passive members.
Further, the LLC Operating Agreement or LP Partnership Agreement are vital documents. They set forth the rights of the Sponsor and Investors. This includes rights to distributions, voting rights, and the Sponsor’s rights to fees for managing the investment.
The LLC or Limited Partnership structure is very similar to the setups of other private funds in the Venture Capital, Private Equity, and Venture Debt space. Such legal entities are there to protect both the Sponsor and the Limited Partners if the deal goes south.
Sponsors and limited partners make money mainly from rental income and property appreciation.
In real estate syndication, rental income is distributed to investors from the General Partner. According to preset terms, this typically occurs on a monthly or quarterly basis. Since a property’s value usually appreciates over time, Limited Partners can net higher rents and earn larger profits when the property is sold.
Payment of profits depends upon the time the investment needs to mature; some syndications are over within 6-12 months while others can take 7-10 years. Everyone who invests receives some share of the profits.
There’s also the call and acquisition fee, which is when Sponsors take an upfront profit at the beginning of the deal for sourcing and acquiring the property. This fee is usually of 1%, although it can be anywhere from .5 to 2% depending upon the transaction.
Before a Sponsor shares in the profits for their work as manager and promoter, all investors receive what is called a ‘preferred return.’ The preferred return is a benchmark payment distributed to all investors. That is usually about 5-10% annually of the initial money invested.
Real Estate Syndication Statistics
- In 2020, over 120,000 investors participated in syndications.
- The average size of a real estate offering was $3 million.
- Passive investors came up with 80-95% of the initial capital investment
- Sponsors came up with 5-20% of the initial capital investment
- Investors received a preferred return ranging from 5-10%.
- The average preferred return was 8%.
- Sponsors netted an acquisition fee of .5 to 2%.
- The average acquisition fee was 1%.
- Sponsors netted a property management fee between 2 and 9%.
As time goes on, investors should expect Sponsor fees to go down and the number of deals to go up. However, as more capital chases more deals, this will put pressure on returns.
How to participate in a Real Estate Syndication
You can choose to either join or start one.
Joining a property syndicate requires you to scout out real estate syndication websites or use your real estate network to find one. You will need to do a lot of homework prior to investing. Knowing how to evaluate a real estate syndication is important when choosing one to join. You need to check the company’s track record, profit split, asset management, investor relations, and exit strategy among other things.
If you don’t want to join an existing syndication company, you can opt to start one. You will need to research and know-how to start a real estate syndication company before you begin. There are some steps that you will need to follow to start a real estate syndication:
- Pick a real estate investing niche
- Decide on an investment strategy
- Design a real estate syndication business plan
- Find real estate investors
- Find properties
The answer to the question of joining or starting a real estate syndication will vary from one person to another. Depending on your financial background and skillset, you can choose to get involved in it as an investor or as a sponsor. When done right, it can be a win-win investment for both parties.